Prolonged high oil prices may hurt economy

Crude oil prices are rising. This is a result of coordinated production cuts by major oil-producing nations, such as the Organization of the Petroleum Exporting Countries (see below) and Russia, which have been ongoing since January 2017. However, if prices continue to rise, it could put a damper on the robust world economy, resulting in decreased oil consumption. Oil producers are discreetly searching for an exit from production cuts.

Threefold rise

U.S. West Texas Intermediate (WTI) crude futures have risen to about $70 per barrel, nearly triple the bottom price seen in February 2016 (see chart 1).

The largest factor for the turn toward rising prices is the deliberate cut in production, amounting to a reduction of 1.8 million barrels a day, by major oil-producing nations including OPEC members, such as Saudi Arabia, Iran and Iraq, and non-OPEC member countries such as Russia, Oman and Azerbaijan. Greater than expected dips in production by nations such as Venezuela, which is racked by political instability, and Mexico, with its obsolete equipment, have also served to push up prices.

The production cuts have caused crude oil stockpiles held by consumer nations to shrink. According to the International Energy Agency (IEA), crude oil stockpiles held by the Organization for Economic Cooperation and Development nations declined from about 3.1 billion barrels in July 2016 to about 2.8 billion barrels in February 2018 (see chart 2).

The announcement by the United States of its withdrawal from the Iran nuclear deal and the preparations to resume its economic sanctions have also spurred higher oil prices. Giovanni Staunovo, an analyst at major Swiss banking firm UBS, predicts that over the next three months, crude oil prices will range from “$65 to $80” per barrel.

For OPEC, this is desirable in the short term, as higher oil prices result directly in an improvement of national finances.

According to the International Monetary Fund (IMF), in order for Saudi Arabia, which boasts the highest oil production in OPEC, to achieve a fiscal surplus, a crude oil price of $87.90 per barrel is necessary. That is more than $10 higher than the current price. In the case of Algeria, it will not achieve a fiscal surplus unless the price rises to $105.70.

However, viewed from a longer-term perspective, rising crude oil prices also have many drawbacks for OPEC.

One of these is that higher prices will bring about profits for companies exploiting shale oil (see below) deposits in North America. This will profit the United States and Canada, which are not members of OPEC.

According to the U.S. Energy Information Administration, U.S. crude oil production is nearing that of world-leading oil producers Saudi Arabia and Russia (See chart 3). If high oil prices continue, development capital will flood into the United States, which could lead to a smaller share of the oil market for OPEC.

Another drawback is the impact on the global economy. High crude oil prices lead to price increases for a variety of goods and services by way of rising gasoline prices, running the risk of adverse effects on economic conditions. If there is a slump in economic activity, it will have the reciprocal effect of reduced oil consumption.

It will also increase the risk of encouraging the use of alternative energy sources, such as natural gas or renewable energy. If prices of $100 per barrel or higher were to become entrenched, oil might be abandoned by the market, having lost its selling point of being cheap and easy to use.

Carbon emissions reduction

Signs of the abandonment of oil are already visible amid growing environmental awareness internationally. Takayuki Honma, a chief economist at Sumitomo Corporation Global Research Co., notes, “The tide has changed with the announcement by Britain and France of a ban on the sales of gasoline and diesel vehicles by 2040.”

The world’s major automakers, led by European manufacturers, are all devoting their efforts to developing electric vehicles. German automaker Volkswagen AG, which was embroiled in an emissions scandal in 2015, was prompted by the revelations to change its course largely toward investment in electric vehicles. The company has set a target to increase the proportion of new car sales made up of EVs and other low-carbon models to 25 percent, or 3 million units per year, by 2025.

The Institute of Energy Economics, Japan estimated long-term trends in oil consumption in October 2017. The estimate is based on two scenarios — one in which the ownership rate of zero-emission vehicles, or electric vehicles, plug-in hybrids and fuel cell vehicles, stalls at 9 percent in 2030 and 20 percent in 2050, and another in which the ownership of such vehicles increases rapidly to 30 percent in 2030 and 100 percent in 2050. According to the estimate, in the case of rapidly increasing ownership, oil consumption would peak around 2030 (See chart 4).

Ken Koyama, managing director of the institute, said, “Oil-producing nations like OPEC, and oil companies as well, have forecast that oil consumption will continue to grow, but they are quite conscious of the trend in the automobile industry.”

Difficult choice

Prolonged high oil prices may induce consumers to move away from gasoline, accelerating the adoption of electric vehicles and other alternatives. If they cease coordinated production cuts and decide to increase production to avert this, it may cause oil prices to crash, once again causing national fiscal conditions to deteriorate. OPEC and Russia are forced to make a difficult choice between securing short-term profits and a survival strategy from the mid- to long-term perspective.

OPEC will hold a meeting in Vienna on June 22 to discuss its response going forward. Depending on how it develops, they could choose to end the coordinated production cuts that are set to continue until the end of 2018 or reduce the scope of the production cuts.

Saudi Arabia, as the leader of OPEC, holds the key. According to Reuters and other sources, Saudi Arabia has indicated its intention that if economic sanctions on Iran are resumed by the United States, resulting in a steep decline in Iranian oil exports, it will make up the production shortfall and increase its production. The aim is to avoid a sharp rise in oil prices.

Over the last few years, Saudi Arabia has been transitioning to an economic framework not solely dependent on crude oil. The establishment of a ¥10 trillion fund in collaboration with SoftBank Group Corp. is one part of these efforts.

According to an Economy, Trade and Industry Ministry official, Saudi Arabia “is looking ahead to the end of the age of oil.”

All eyes are focused on Saudi Arabia’s next moves as it embarks on reforms.

no one can escape it, without it we return to the economy of the farmcart and the sailing ship—(if we’re lucky)

that force has a single origin, fossil fuels, and to imagine that ”alternatives” are going to replace fossil fuels is taking fantasy to ridiculous extremes. We built our industrial world on oil that was cheap, and provided colossal amounts of surplus energy from oilwells that delivered energy returns of 100:1

we are now fantasising that returns of 6:1 from wind and solar farms will deliver the same end results. —So we make laws that ban IC vehicles, on the assumption that we can continue BAU without them.

by 2040 petrol powered vehicles will be irrelevant, because there will be no oil available. It won’t be necessary to ”ban it”

And as for Saudi switching to an ”alternative economic model”—that is ludicrous.

Pre oil, Saudi support about 1 million people. Now there are 30 million. Within 10 years they will have no oil available for export. with which to buy food. That is their brutal future. And they know it.

There will be no ”alternatives” for their population, who have grown used to oil-support
spending $trillions will not refill oilwells

marmico on Mon, 28th May 2018 6:38 am

The brutal reality is that our energy driven system is becoming unaffordable, and it cannot support 7.5bn people, let alone the 9 bn forecast by mid century

BS. US energy consumption per capita is the same as it was in 1968 and is more affordable (energy spending divided by GDP) in 2018.

MASTERMIND on Mon, 28th May 2018 6:46 am

Marmico

More affordable? The average price of a barrel of oil post ww2-2000 was 19 dollars a barrel (inflation adjusted)..

The US restless consumer doesn’t have enough disposal income to absorb rising fuel cost. Couple that with rising interest rates plus inflation and the result will be a slowdown in consumer spending.

Corporate America with its new found wealth thanks to tax cuts is spending their windfall on stock buybacks and dividends. As the disconnect between Wall street and Main street widens the real economy will grind to a stand still. The Fed knows this which is why they are turning dovish on their forecast to bring interest rates back to the norm. There is few arrows in the Feds quiver to bail out the economy once it slips into recession.

MASTERMIND on Mon, 28th May 2018 8:06 am

marmico

During the mid/late 20th century (1960-1999), a barrel of oil cost $19 on average; during the years immediately prior to the Great Recession (2000-2008), the average price of a barrel of oil had increased to $47; and during the years immediately following the Great Recession (2010-2012), the average price of a barrel of oil had further increased to $81. During the same three time periods, the average price of a metric ton of copper increased from $3,085, to $3,713, to $6,817; the average price of a metric ton of iron ore increased from $36, to $57, to $124; and the average price of a metric ton of potash increased from $114, to $185, to $343. (Prices are inflation adjusted.)

The simple fact is that we cannot grow our global economy and improve our global material living standards on $55 oil, $6,817 copper, $124 iron ore, and $343 potash like we did on $19 oil, $3,085 copper, $36 iron ore, and $114 potash. It should come as no surprise that our Non Renewable Resource-dependent global economy experienced the Great Recession during 2009. Nor should it come as a surprise that we have yet to recover from the Great Recession. Nor will our industrialized and industrializing economies ever recover, so long as price levels associated with the vast majority of Non Renewable Resources remain at their inordinately high levels.

Bloomer, the Us is already in a recession. What is coming is a massive depression on a scale that makes the Great Depression look like a mild headache. Debt is rampant all over America in every financial system.

MASTERMIND on Mon, 28th May 2018 8:49 am

The Trump effect: New study connects white American intolerance and support for authoritarianism

Politically speaking, tribal nationalism always insists that its own people is surrounded by “a world of enemies”, “one against all”, that a fundamental difference exists between this people and all others. It claims its people to be unique, individual, incompatible with all others, and denies theoretically the very possibility of a common mankind long before it is used to destroy the humanity of man..

-Hannah Arendt
The Origins of Totalitarianism

Davy on Mon, 28th May 2018 9:30 am

“The US restless consumer doesn’t have enough disposal income to absorb rising fuel cost. Couple that with rising interest rates plus inflation and the result will be a slowdown in consumer spending.”
Quantify that bloomer and which consumer class?

“Corporate America with its new found wealth thanks to tax cuts is spending their windfall on stock buybacks and dividends.”
Dividends and pay increases for employees are a demand booster.

“As the disconnect between Wall street and Main street widens the real economy will grind to a stand still.”
I have heard that so many times out of you guys but this is not much wider now then a few years ago. The real widening happened post 08 crisis and has not widened much since then.

“The Fed knows this which is why they are turning dovish on their forecast to bring interest rates back to the norm. There is few arrows in the Feds quiver to bail out the economy once it slips into recession.”
This is why the Fed is tightening? I don’t think so. It is more like multiple reasons one being a preparation for the next possible economic cycle. The other is inflation rising especially with financial assets. Employment is tight with those in the workforce and in demand.

Boat on Mon, 28th May 2018 9:31 am

Weak minds like to be ruled and given no say. Guys like mak and Clog long for a Hitler type to control them. They love the idea of expanding territory so others like Jews can’t out think or out manipulate them.
Take away the press and accountability so their dumbed down life can be in peace. This is why Putin types are appealing. The stress of fear and competing is just to much.

Davy on Mon, 28th May 2018 9:33 am

“Bloomer, the Us is already in a recession. What is coming is a massive depression on a scale that makes the Great Depression look like a mild headache. Debt is rampant all over America in every financial system.”

3rd world, do you have any references to back up that statement? I mean come on that is about as broad and as stupid as it gets from an economic illiterate.

marmico on Mon, 28th May 2018 9:49 am

During the mid/late 20th century (1960-1999), a barrel of oil cost $19 on average; during the years immediately prior to the Great Recession (2000-2008), the average price of a barrel of oil had increased to $47; and during the years immediately following the Great Recession (2010-2012), the average price of a barrel of oil had further increased to $81.

And how many barrels of oil did you buy between 1960 and 2018?

Refiners buy oil, consumers buy oil products. It takes less hours of work for Jane Chardonnay to buy enough gasoline in 2018 to travel 100 miles than it did in 1960.

Maybe you can convince The Turdburger to prove otherwise.

Boat on Mon, 28th May 2018 9:51 am

If you drive quite a bit you spend an extra $60 a month. Hardly a budget busting experience. As the months go by marginally higher prices will ripple through the system but oil under $80 is not economy destroying news. Electricity prices should remain stable which equals transportation in consumption.

GregT on Mon, 28th May 2018 10:34 am

“As the months go by marginally higher prices will ripple through the system but oil under $80 is not economy destroying news.”

$80/bbl oil is not marginally higher Boat. It would be ~300% higher than a century of oil prices during non-recessionary periods in inflation adjusted dollars, and the economy has already been on central bank policy life support since the Great Recession began back around 2007/2008, which our economies have still not recovered from.

The economy, for all intents and purposes, has already been destroyed. Enjoy that free fall Wiley Coyote moment while it lasts. The canyon floor is rapidly approaching. Splat.

Life may be all fun and games now in the USA, but as offshoring increases, illegal immigration rises, hard-working Americans die off or dropout due to higher taxes and more regulations, the national debt climbs, there is more terrorism as the result of illegal American wars, the police become more brutal enforcing draconian decrees, the US Ponzi economy and stock markets collapse, cash is banned, Americans are implanted with microchips, and real crises and false flags are used to force Americans to go to the gulags and finally to the gas chambers and ovens, will Americans wish that they had spoken out earlier against the dangers of wars, debt, and tyranny?

Manila1 on Wed, 30th May 2018 8:59 am

Free, your picture of America is very accurate as is your question. Most Americans don’t feel the water heating up. Those who do are getting out while they can.